Goldman, The Contrarian?

“I’m a contrarian, so when everyone else is capitulating, I think it’s time to invest.”

So says Stuart Bernstein, the partner in charge of cleantech at Goldman Sachs (NYSE:  GS), in this recent article about the ending slump of renewable energy financing.

“It feels like the worst is behind us…The market appears to have troughed in the fourth quarter of last year and several sectors have rallied meaningfully since then.”

At least Stuart himself and Goldman as a firm have reason to be bullish.  As the article reports, data from Bloomberg New Energy Finance has Goldman overtaking the top spot among investment banks in renewable energy stock offerings during 2012, with $405 million underwritten.

To be fair, it must be said that this represents resumption of leadership in a shrinking pie:  according to this companion article, global clean energy investment fell by 11% in 2012 relative to the prior year.

And, it must also be noted that Bernstein had more or less the same message almost a year ago, in his comments to the Cleantech Forum in San Francisco last March, when it was reported by Ucilia Wang of GigaOM that he said that cleantech “was certainly in the recovery period.”

In Bernstein’s favor, the long-term dynamics remain positive, whether or not we’ve hit bottom in the short-term.  “We have a growing global population coupled with an increasing per capita consumption of energy, while fossil resources are finite and shrinking.  How can one not consider clean energy and renewable alternatives?”

Let’s hope Bernstein is right.  I think he’s right.  But then again, I’m a contrarian too.


Batteries Are Hot! (Just Ask Boeing)

Boeing (NYSE: BA) may soon be on the verge of renaming its new 787 the Nightmareliner…

After a prolonged development program and costly production delays, Boeing started delivering its latest state-of-the-art airplane just 15 months ago, three years behind schedule.  Although the company has a lucrative backlog of nearly 800 787s on order, worth roughly $200 billion in revenues, production rates have been limited, as only 50 units have been delivered in a little over a year.

Alas, opening the production floodgates is not likely to happen just now.  In early limited service with a few airlines, the 787 is causing Boeing and its customers major headaches.  Thankfully, no-one has been injured, but a number of high-profile malfunctions have caused significant operational issues.

None has been worse than last week’s emergency landing in Japan, prompted by a burning smell in the cockpit.  This followed closely on the heels of an on-the-ground fire in Boston the previous week, upon which one aviation observer noted:  “Onboard fires on airplanes are as bad as it gets.”

These two incidents in close sequence produced a “That’s It!” moment, wherein all the aviation authorities worldwide put their collective feet down and issued orders to ground all 787s until the deficiencies have been identified and resolved.  There hasn’t been any similar draconian action in over 30 years, since the grounding of all DC-10s after the disastrous American Airlines 191 crash on takeoff at O’Hare in May 1979.

The most critical problems for the 787 all seem to relate to the batteries on board the plane.  The 787 design uses lithium-ion batteries made by GS Yuasa (6674) for many more functions than most airliners in order to maximize fuel efficiency.

Used in consumer electronics and electric vehicles, lithium-ion batteries are desirable because of their high energy/power density.  Simply put, they are very powerful for their size and weight — and in an airplane, size and weight matter a lot, especially when fuel efficiency is the goal.

Unfortunately, directly related to their high energy/power density, lithium-ion batteries are known to get hot.  Thermal management is critical, or else lithium-ion batteries start bulging and leaking electrolyte, which is highly corrosive.  Moreover, if the batteries don’t start bulging and leaking in response to increasing temperatures, a far worse fate could potentially arise:  explosions and/or fires.

This is not news.   A few years ago, Hewlett-Packard (NYSE: HPQ) settled a class action lawsuit involving burning laptops caused by lithium-ion battery fires.  Indeed, these experiences with lithium-ion batteries caused some to wonder if their use should be banned from airplanes for safety reasons.

Given this history of potential concern, you would think that Boeing would have moved heaven-and-earth to ensure that any lithium-ion battery on the 787 couldn’t experience a comparable problem.  Indeed, according to this article, Boeing engineers attest that the battery design now in use in the 787 was tested for a cumulative 1.3 million hours without failure.

It may not be easy to diagnose and solve a problem that hadn’t surfaced in 1.3 million previous hours.  Worryingly for all involved, GS Yuasa thinks it may take months to get to the bottom of the issues.

Two dissimilar reports over the weekend offer some hope for the principals that the solution will be sooner rather than later.  One story hinted that the battery problems may be confined to one batch of production.  Another story indicated that the two toasted batteries had been fed excessive voltage by their power supply system — a problem that perhaps could be resolved more easily.

Even if it’s a short hiccup, this is exceptionally costly to Boeing.  Not only is Boeing likely to have to cease new 787 production causing further delivery delays, face compensatory payments to airlines for their hardships, and incur increased costs in implementing whatever fixes are necessary on completed and already-in-the-queue units, but the potential credibility damage is enormous, even if unquantifiable.

For a company rooted in commercial aviation, nothing is more important than its safety reputation, which Boeing has built so superbly for nearly a century.   (“If it ain’t Boeing, I ain’t going.”)

At least three implications emerge from this escapade for the cleantech world:

  • Early adopters of new technologies in mission-critical application with large attached liabilities will be highly risk-averse.  The economic advantages afforded by improvement have to far outweigh the possible consequences of failure.
  • Lithium-ion batteries take another kick in the stomach.  As this posting by John Voelcker suggests, it will also hit the cause of electric vehicles, rightly or wrongly.
  • Battery technology still needs a lot of work — either to improve lithium-ion batteries or to develop commercially-viable substitutes with similar energy/power density.  Here is a recent posting by GigaOM blogger Katie Fehrenbacher entitled “13 Battery Startups to Watch in 2013.”

Why is it So Hard to Make Money in New Battery Technology?

Energy storage is still the rage in cleantech.  But after the collapse of A123 and Beacon, and the spectacular failure on the Fisker Karma in its Consumer Reports tests, fire  in Hawaii with Xtreme Power’s lead acid grid storage system and with NGK’s sodium sulphur system, and now battery problems grounding the Boeing Dreamliners, investors in batteries are again divided into the jaded camp, and the koolaid drinker camp.   Not a perjorative, just reality.  New batteries and energy storage is still one of the juiciest promised lands in energy.  And still undeniably hard.  Basically, investors are relearning lessons we learned a decade ago.

Batteries are just hard.  Investing in them is hard.  Commercialization of batteries is hard. So why is it so difficult to make money in new battery technology?

Above and beyond the numbers, there are a number of commonalities related to the commercialization and venture financing life cycle of battery technologies that seem to differ to some degree from other venture investments in IT or even other energy technologies.  Having looked at probably 100+ deals over the years, and on the back of an deep study we did a couple of years ago on benchmarking valuations in energy storage, here’s our take on the why.

Timing – Battery technology commercializations have historically tended to be one of the slower commercialization cycles from lab stage to market.  Startups and investors in batteries have a long history of underestimating both the development cycle, capital required, and the commercialization cycle, as well as underestimating the competitiveness of the market.

Special chemistry risk – There is significant risk in launching a technology in newer battery chemistry.  There have been only a limited number of new chemistries succeed, and when they do, as in the case of NiMH and Energy Conversion Devices, they are typically either co-opted by larger competitors obviating a first mover advantage (that advantage is typically much weaker in this field than others) or requiring expensive patent suits.  Also as in the case of NiMH, there is no guarantee the chemistry will have legs (just when it is hitting its stride, NiMH is already becoming eclipsed by Li-On.  This risk has proven to be especially high for new chemistries (like Zn type) that are not as widely researched, as the supply chain development does not keep pace.  In addition, the battery field is highly crowded, and research is old enough that and despite new chemistry in most cases truly defensible patent positions are extremely hard to come by, or provide only discrete advantages (ability to supply a range of quality product cheaply in high volumes (or with value add to the product) seems to be the primary competitive advantage).  Few battery technologies of any chemistry end up their commercialization cycle with anywhere near as sustained an advantage as their inventors expected.

High capital costs – In any case, almost all battery startups will require extremely large amounts of capital (on the order of US$50 to 100 mm+) to achieve commercialization (much higher for real manufacturing scale), and the end product margins tend not to be particularly high.  Even with stage gate, a very large portion of this investment (US$10-50 mm+), is generally required to be spent while the risk of technical and economic failure is still high.  In addition, during the manufacturing scale up phase post R&D, capital investment required per $1 of revenue growth tends to be linear, making these technologies capital intensive to grow.

Degradation of initial technical advantage – In many technology areas one can expect the performance of the final manufactured product to improve over the performance in initial lab results, In part because of the low cost target, high reliability, high volume requirements of this product type however, promising battery technologies, are often forced to make compromises in the scale up, manufacturing, and commercialization stages that mean the performance of actual product might be expected to fall from levels or rates seen in lab scale experiments (though cost may go the other way).    At the same time, battery performance of standard technologies, while mature, is a moving target, and during the time frame for commercialization, will often improve enough to obviate the need for the remaining technical advantages.

Size matters – Most battery products (whether batteries or components like anode or cathode materials or electrolyte), are sold to large customers with very large volume requirements, and highly competitive quality and performance requirements.  As a result, breaking into new markets generally is extremely hard to do in niche markets, and means a battery startup must prove itself and its technology farther and for a longer period of time than other technology areas (see capital costs, timing and down rounds).  Many battery components technology developers as a result will be relegated for early adopters to emerging customers with high risks in their own commercialization path.

Lack of superior economics from licensing – As a result of these size, capital cost, timing, and commercialization risk issues most battery technologies will command much lower and more short-lived economics than anticipated from licensing (or require expensive patent lawsuits to achieve), and will require almost as late a stage of development (ie manufacturing operating at scale with proof of volume customers) and commensurate capital requirements, as taking the product to market directly.

Propensity for down rounds – In addition, battery technology companies tend to have down rounds in much larger numbers in the post A rounds (Series B through D+) than other venture investment areas, as these challenges catch-up to investors and management teams who overestimated the scope of work, capital and timing required in the seed, A and B rounds.  In particular, battery investors have tended to invest in seed, A and B stage battery technologies (pre-scaled up manufacturing process or even lab and prototype scale) with expectations of typical venture style timing and economics.  Quite often instead, it is the B, C, or D investor group that post cram-down rounds achieve the Series A economics (even when the technology IS successful), and the seed, A and B investors suffer losses or subpar IRRs.

How To Fail In Cleantech

The transition to cleantech – some would call it a revolution – inevitably entails change, which implies risk.  In turn, this implies that some things will fail.

We’ve already seen more than a few failures, and we’ll no doubt see many more.

As long as the successes outweigh the failures, that’s all that ultimately matters.  Indeed, sometimes failure actually enables later successes.

As Thomas Edison has been quoted, “I have not failed.  I’ve just found 10,000 ways that won’t work.”  And, then finally — ta-da! — he discovered an approach that worked for the incandescent lightbulb, thereby changing the world forever.

But, sometimes failures can get in the way of success – particularly, if they’re the wrong kind of failures.

Edison failed quickly, cheaply and – perhaps most importantly – invisibly.  Some of cleantech’s most painful failures have been anything but.

Consider two prominent examples:  Solyndra and A123.  The technologies being developed by the two companies actually work well enough, but couldn’t compete effectively in the marketplace.

The management teams and the backers of these companies promised great things with premature hype in innumerable press releases.  The companies blew through lots of capital – including substantial government funding.

Then, they fly off the cliff and go bust, and the media and blogosphere — much of which is adverse to cleantech — report their demises with barely-hidden Schadenfreude.

OK, so it’s not like a mass shooting spree:  no-one got killed in these failures.  But equity holders lost every dollar, creditors took a deep haircut, taxpayer money was wasted, and pretty much everyone active in the cleantech sector gets tainted by extension.

As bad as economic failures, worse is when technologies fail because they simply don’t work.

The earliest windfarms of the mid-1980s in California became an eyesore of inoperative machinery, because the turbines were deployed in mass quantity before many engineering and manufacturing problems had been fully resolved.  In the wake of this debacle, the U.S. wind industry took more than a decade to recover.  By the time wind energy had regained credibility in America, European wind turbine manufacturers dominated the market.

These visions returned to me during a recent trip to Oahu, where my lodging provided me an ongoing view of the Kahuku windfarm standing idle in the face of a week of strong trade-winds.  My first thought was a serial failure of the turbines – a relatively new 2.5 megawatt design from Clipper, a manufacturer with known technical issues.

However, as this report indicates, the root cause of the shutdown was unrelated to the wind turbines, but rather some problem with a set of grid-scale batteries being developed by Xtreme Power, and being piloted at the site to test the ability of such batteries to buffer the variable output of a windfarm.  The pilot deployment had caused not one but three fires somehow involving the interconnection between the windfarm and the Hawaiian Electric grid, thus causing the windfarm to be idled while sorting out the battery issues.

Why weren’t these batteries tested in smaller scale and in a less obvious setting?  Not only is the image of Xtreme Power (and grid-scale energy storage) being adversely affected, the long shutdown of Kahuku is dampening enthusiasm for wind energy in Hawaii.

It is these kinds of visible economic or technical failures that give the cleantech sector a black eye.   The bad reputation diminishes civic goodwill, support for favorable public policies, and appetite for private capital to be allocated to the sector.

Unlike Edison’s failures, largely unnoticed by the rest of the world while he returned again and again to the drawing board, visible cleantech failures are distinctly unhelpful.

Such episodes are very painful for those of us on the sidelines working humbly to maintain forward progress in spite of the setbacks that inevitably occur in this long and challenging cleantech transition.

In the venture capital world, it is axiomatic to fail fast, so as to minimize capital at risk.  For cleantech, this adage should be modified:  fail fast, and stealthy.

The implication:  cleantech ventures — and their investors — are well-advised to maintain a low profile for a long time, until their success is reasonably assured.  It’s far better to underpromise and overdeliver than vice versa.  Humility is essential.  Premature bragging is very easy to eviscerate by the pundits hungry for a tussle when things later go bad.

The more that cleantech entrepreneurs can avoid shooting themselves in the foot when the spotlight is on them — first and foremost, by not encouraging the spotlight to be shined upon them — the better.

Is the Avis / ZipCar Acquisition Green?

I am selling my little Honda in California, since I moved to Texas two years ago, I left a car in San Francisco to drive when I’m here.

So I’d been looking into getting car share.  Absolutely loving the concept, been trying to figure out if it is a better deal for me than renting when I come out.

So when Avis dropped half a billion dollars on ZipCar, I was pretty intrigued.  Which raised the question, does this count as a cleantech or green exit?

I mean, I’ve rejected the “IT services instead of flying argument” making web conferencing services a product green, something I used to get emails on from marketers all the time.

Zipcar’s a little like that.  Are fewer miles actually driven?  Less gas used?

How about fewer cars bought?  Is Zipcar actually replacing cars?  Or adding cars and increasing miles driven by bringing new drivers into the fleet, or making some time drivers into more of the time drivers and reducing public transit use?  I’m not sure that car rentals like Avis don’t increase the number of vehicles and maybe even miles per person in the US.

When does efficiency and better shared services instead of capital expenditures become green, and not just a good deal?

Energy Cache: Avoiding Cleantech’s Catch-22

Recently, I came across this very interesting thought-piece, “Cleantech Marketing Isn’t IT Marketing”, written by Aaron Fike, the founder and CEO of Energy Cache.

Energy Cache has developed a rather unusual energy storage technology.  As described here, Energy Cache is offering a solution that is a hybrid of ski-lifts and mining technology, hauling gravel in buckets to the top of a hill.  An offshoot of pumped hydro, Energy Cache consumes electricity during off-peak hours (when electricity is cheap) to lift the gravel, and allows the gravel to fall in the buckets, exploiting gravity to power a generator during peak hours (when electricity is much more valuable).

As Fike notes in his recent commentary, Energy Cache has been the butt of jokes among certain of its peers for its less-than-high technology approach to solving one of the more important needs facing the energy sector:  an effective grid-scale storage approach that enables more power to be generated from intermittent wind and solar energy sources.

In contrast to Energy Cache, Fike worries that a number of other cleantech businesses “don’t follow the traditional ‘early adopters/early majority/late majority’ model made famous by Geoffrey Moore, and before that, by Everett Rogers.  Instead, with the siren song of the cleantech market being the sheer size of the potential market, most firms position themselves to enter the market by skipping the early-adopters phase, because there is no early-adopters phase.”

Fike continues:  “What happens instead is that a company will build a reasonably sized demonstration…and the next attempted step is a [twenty times bigger] plant, with no reasonable path in between.  The problem with that step function is that it is nearly impossible to deliver on [because it] requires hundreds of millions of dollars in debt and equity – financing that won’t come without a well-proven track record of performance…Customers and financiers all want to be first in line to back the third major installation…The vicious Catch-22 of ‘You can’t get funding until it is proven; you can’t prove it without funding’ is incredibly strong.  Nobody wants to be first.”

To avoid this conundrum, Fike says that Energy Cache consciously looked to develop a business that involved as little technology risk as possible.  “When I founded the company, I felt that the biggest problem facing clean technology companies was the marketing and financing problem discussed above, not the technology problem.  I set out to come up with a solution which used components from proven industries that we could point to, reducing uncertainty about lifetime, performance, and cost.”

At the conceptual level, without passing judgment on Energy Cache specifically, I think what Fike asserts so far is absolutely terrific, though I disagree with Fike when he later states that “the implicit demands of the investment community and the government finance community are for cool, breakthrough, technology-focused solutions.”

Well, I can’t speak for the “government finance” (i.e., hand-out) community, but as a card-carrying member of the investment community, I can unequivocally state that I (along with many others I know) really don’t care how wonderful a technology is if it can’t make any money.  I also really don’t care how mundane a technology is if it makes good money.  I am eager to find a boring unsexy investment opportunity that translates to profitable rapid growth with a high-value exit.

That being said, it is usually the case that a high-value exit is only achieved for companies that offer something proprietary — which in turn usually involves technology protected by both issued patents and trade-secret know-how — that prevents other companies from copying the formula for success.  This is more often applicable to advanced technologies, though it certainly can apply to low-tech as well.

Maybe Energy Cache has found a technology that offers the ideal combination of proven simplicity and defensible competitive advantage.  For many cleantech companies based on more ambitious technologies, Fike closes with a pithy forecast of the unpleasant fate ahead:

“Technology and IT market innovators and early adopters love new technology and are willing to take technology risk to adopt new products.  Regulated energy and utility markets do not like, and in some cases are forbidden from, taking technology risk.  To grow a cleantech company without recognizing these facts will result in a very painful impact with a very high brick wall.”

However sobering, this advice is a good reminder for all of us working in the cleantech realm to reflect upon periodically.